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[Editorial] U.S. rate hike

Policymakers need to guard against fallout

Investors as well as policymakers around the world are on alert as the U.S. Federal Reserve has finally raised its benchmark interest rate for the first time in nearly a decade.

The U.S. central bank hiked Wednesday the federal funds rate by a quarter of a percentage point to between 0.25 percent and 0.50 percent, putting an end to the era of zero interest rates.

The Fed’s move did not cause turmoil in global financial and commodities markets. In fact, stock markets in Korea and other major countries rallied as one big uncertainty hanging over them has at last dissipated.

Fed Chair Janet Yellen eased market jitters by assuring unequivocally that further rate hikes would be gradual. The next rate increase is expected to come in April 2016.

Yet one should not read too much into the initial market response. Korean policymakers have reason to raise their guard against the potential fallout from the shift in U.S. monetary policy.

The Fed’s move is cause for concern primarily because it could detonate Korea’s household debt bomb. The Bank of Korea is unlikely to raise interest rates immediately, but may have to follow suit sometime next year. Before interest rates begin to rise in Korea, policymakers need to move proactively to prevent the ticking time bomb from going off.

Policymakers also need to closely monitor global financial markets as the U.S. rate hike could trigger disruptive capital outflows.

Korea is unlikely to suffer destabilizing capital outflows as its substantial current account surplus, large foreign currency reserves and sound government finances clearly differentiate it from other emerging economies.

But higher U.S. interest rates could exacerbate the ongoing currency turmoil in many emerging markets. Since last year, many exporting countries have suffered a sharp decline in the value of their currencies as global demand for their commodities dropped.

The sharp currency depreciation put these countries in trouble as it reduced their export revenues while at the same time increasing the cost of paying off debts denominated in foreign currencies.

A stronger dollar could further increase their debt burden by making their currencies cheaper. As a result, countries with insufficient foreign currency reserves could have difficulty repaying debts.

As the global financial system is highly integrated, a crisis in one country or region can easily spread to other markets. Korea is vulnerable to such contagions as it is a highly open economy.

Following the global financial crisis in 2008, Korea devised a set of measures to shield itself from external shocks. But these tools were designed to curb large capital inflows. What the nation needs now is measures to prevent massive capital outflows.

Policymakers also need to keep an eye on China’s currency policy. The Chinese yuan is currently pegged to the greenback, which means that a stronger dollar will also make the yuan gain strength.

Yet the Chinese government does not want a stronger yuan. So it has recently intervened in the currency market to lower its value. Following the U.S. rate hike, China is likely to further depreciate its currency.

A cheaper yuan is bad for Korean exporters as it makes Chinese products cheaper vis-a-vis Korean goods. Korean policymakers are advised to gradually weaken the Korean currency against the yuan.


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